By Stuart Talman, XE currency strategist
The two major news stories for financial markets over the past 24 hours have been the release of US CPI data for April and the US government’s debt ceiling impasse. As widely expected, President Biden’s meeting with congressional leaders delivered no progress on lifting the limit whilst inflation metrics have printed in-line with consensus estimates.
Risk assets continue to trade near the top of prevailing ranges, threatening to break out, but yet to do so given the absence of a near-term catalyst and the inevitable erosion of confidence that another debt ceiling saga will cause.
The New Zealand dollar has extended the prevailing rally that commenced a couple of weeks back, reaching its highest level since mid-February. Logging Wednesday’s overnight high a couple of pips through 0.6380, initially spiking higher following the US CPI numbers, the Kiwi has ranged between 0.6340 and 0.6380 through US trade.
Both core and headline inflation rose 0.4% MoM, yielding an annualised 5.5% and 4.9% respectively. Whilst headline inflation peaked at 9.1% in June and core at 6.6% in September, prices are still running far too hot for comfort, remaining well above the Fed’s 2%inflation target.
An average monthly reading of 0.17% over time is required to return inflation to 2%.
Inflation remaining persistently high justifies the Fed’s mantra to hold the Fed funds rate at its peak for a prolonged period. Fed Chair Powell and his colleagues are adamant they will not be cutting rates any time soon.
The market disagrees, pricing in monetary easing to commence within a few months as the Fed’s historically rapid pace of tightening “breaks something.” Widespread banking sector stress exacerbated by commercial real estate defaults is a popular pick for those who believe a larger financial crisis is imminent.
Whilst on the topic of stress, the US debt ceiling impasse is likely to spike stress levels over the coming weeks.
Congressional leaders met yesterday in an attempt to find some middle ground as the early June “X-date” looms.
Currently set at US$31.38 trillion, Treasury Secretary Janet Yellen has flagged early June as the date when the US government will again max out its ability to continue borrowing having reached the ceiling earlier in the year, triggering the need to implement extraordinary measures to maintain current spending levels.
What’s the likelihood that republicans and democrats won’t reach a deal causing the US government to default?
Zero…..it won’t happen.
The US has never defaulted on its debt.
So why all the fuss if we know the playbook, and as was the case in 2011, the US government reaches an agreement at the 11th hour.
It’s a volatility inducing event.
The impasse over raising the limit stems from opposing views within congress – Democrats want to raise the debt limit, whilst Republicans don’t and/or demand spending cuts.
The political brinkmanship that ensues erodes business and household confidence, delivering a period of heightened volatility across most asset classes.
Back in 2011, when a deal was struck 72 hours prior to the X-date, US equities were crunched, the S&P 500 falling close to 20% from July through August. Given the lack of confidence in the US economy and the dollar, the Japanese yen is a standout performer during these periods, attracting the bulk of safe-haven flows.
Peaking through 0.88 in August of 2011, the New Zealand dollar then aggressively U-turned in the three months that followed, falling over 15%, trading sub-0.74 through November.
Although, the debt ceiling was not the sole major storyline influencing the markets direction through the second half of 2011, risk sentiment also eroded via the European sovereign debt crisis.
Retuning to the present, should the US dollar again temporarily lose it safe-haven status due to political and economic uncertainty, NZDUSD stages a topside breakout and extends higher to challenge the year to date high near 0.6540.
The other, unlikely scenario is that a deal is struck over the next few weeks, putting a follow under the dollar.
Time is running out given upcoming recess periods for both the senate and the house and President Biden’s schedule….leaving just seven days for Republicans and Democrats to agree on lifting the ceiling.
To the day ahead, the Bank of England’s interest rate decision is the headline event, UK’s central bank widely expected to hike by another 25bps, lifting the policy rate to 4.50%.
Whilst recent editions of inflation and wages data surprised to the upside, the BoE likely joins its major central bank peers in pausing the cycle within the next couple of meetings, affording itself a period to assess monetary policy’s lag effects.
The pound has been one of the strongest performing currencies, year-to-date, ascending into technical overbought levels against the dollar and its crosses.
Marking 12-month lows near 0.49 a couple of weeks prior, NZDGBP has rebounded close to 3%, signalling a prominent bottom has formed as the BoE nears the end of its tightening cycle.
Given the UK economy is holding up reasonably well and the global growth outlook remains murky, its unlikely the Kiwi manages a period of sustained outperformance versus the pound. Having improved back through 0.50, we look for NZDGBP to range between 0.4950 and 0.5100 as we head into the second half of the year.
CPI for China and weekly jobless claims are the data points of note for Thursday.
We suspect US equites, the New Zealand dollar and other risk sensitive assets continue to trade near the top of current ranges with the upside bias to be challenged as we approach the X-date and the debt ceiling impasse endures.
Our key NZDUSD level to monitor: 0.6380.
Wednesday’s high and the 05 April RBNZ (surprise 50bps hike) induced high are both within a few pips of 0.6380.
Should price action extend through here to find a foothold above 64 US cents, the probability of a challenge of the 0.6538 year-to-date high materially increases.
Daily exchange rates
Select chart tabs
Stuart Talman is Director of Sales at XE. You can contact him here.
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.